Closed European and Chinese markets give us the chance to take a look at the big picture in US equities and analyze the risks to the economic recovery and bull market. While we are well aware of the dead horses of Spanish debt and Chinese hard-landing that reporters like to blame/credit for every daily movement, the real questions are whether these factors are properly priced in; what really needs to happen to surprise investors and cause a major reversal; and what is the probability of such an event given what we know now.
In Europe the situation is admittedly weak with Spain in an official recession and as more countries deal with debt issues and implement austerity there are most likely others to follow. Low growth and low demand are already weighing on the U.K. as their PMI number indicated weakness in manufacturing exports, but a broader recession is largely expected and unlikely to severely derail the US as Europe works through its structural issues and sets itself on a path to sustainability and growth. That said, a more severe and sudden market event such as a major European bank failure would have a destabilizing effect on our market. At the moment they are sufficiently capitalized and the ECB continues to keep a lid on sovereign yields, further supporting balance sheets. I do not see the ECB suspending its bond buying programs in the medium term so the probability of a severe liquidity crisis is low.
China’s slower (but still high) growth will definitely have an impact on American companies that have leaned on expansion to drive global growth but so far domestic manufacturing activity has muted the adverse effects. While writing, the ISM released better-than-expected manufacturing numbers indicating stable to strong demand and better New Orders, Production, and Employment data. The short-term trader still faces China’s headline risk but the systemic shift from an export and real-estate investment-driven economy to a consumption economy will be beneficial for China’s long-term development and, in turn, American multi-nationals.
I remain bullish on US stocks as I believe current known risks in Europe and China are properly priced and US economic data reflects a steady-to-improving environment. Companies have been able beat overly-pessimistic expectations and low interest rates for an extended period will continue to provide a boost to demand and employment as housing seeks a bottom.
